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Corporate bond market: The new liquidity trap

The liquidity-starved corporate bond market desperately needs to find a post-regulation equilibrium. Banks just can’t commit capital to market-making. So the smarter investors are looking at ways of delivering it themselves.

Despite record new issuance, the corporate bond market is still dogged by secondary market illiquidity. There is a chronic lack of risk appetite – particularly among hedge funds – and real money accounts are not straying very far from their benchmarks. This has driven investors into the new issue market where deals are attracting huge oversubscription.

"You could sit there and hope or you can do something. No one is going to replace the $200 billion that has gone from dealer balance sheets”
-Rich Prager, BlackRock.

But illiquidity persists. “Buyers then tend to lock it away, hold on to it and are reluctant to trade – it is a chicken and egg situation,” Rich Herman, head of the institutional client group at Deutsche Bank in London tells Euromoney. Just how to get the secondary markets moving again is one of the corporate bond market’s greatest challenges. Just 1.6% of bonds traded in the US during 2011 traded on a daily basis and liquidity is increasingly concentrated on a small number of names.

Large buyside firms are taking the situation into their own hands. “You could just sit there and hope or you can do something. No one is going to replace the $200 billion that has gone from dealer balance sheets,” warns Rich Prager, New York-based head of trading and liquidity strategies at BlackRock. “There is a lot less risk capital available to support activities that the buy side has become accustomed to – like market making.”

Others hope that electronic trading will restore secondary trading volumes, and the equification of FICC may become a reality. But can credit ever be anything but an over the counter market? And will instant liquidity ever return?


Read the full Euromoney report into the lack of liquidity in global bond markets, and what can be done to improve it, in Euromoney's October edition.


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